A study released by the German Association of Renewable Energy (“Bundesverband Erneuerbare Energie e. V., “BEE”) in April 2010 shows that Germany’s annual investment in renewable energy will reach almost Euro 29 billion by the year 2020.
According to this study the investment in renewable energy will add up to more than Euro 235 billion over the next 10 years.
Investments in electricity will represent a share of 67% of this amount with investments in wind energy being the biggest part of it.
However, because of saturation of onshore wind farm capacity, project developers and investors will seek for other investment opportunities, e. g. the internationalisation of their projects.
In order to get debt capital and to secure the success of such international projects, developers should pay increased attention to the regulatory framework of the host country of the wind power plant and its membership in international organizations (e. g. the Energy Charter Treaty).
The regulatory framework of the host country should provide a stimulatory tax climate and a successful system of law enforcement.
Depending on the character of the promotion system of the host county, there should either be an effective system for tradable certificates, a clear feed in tariff mechanism or an effective bidding system.
Other decisive issues are the condition of the grid, the power off-take attractiveness and the overall infrastructure of the host country.
The investment will then be realized by the community wind fund itself, a wholly-owned special purpose vehicle or by a co-partner investment fund domiciled in the host country.
In order to reduce the burden of tax compliance the international structure of the community wind fund should assure that no individual investor is obliged to file a tax return in the host country.
Besides these factors, developers in Germany have to consider legal and tax consequences resulting from the international structure of the wind farm project.
Against this background, this article seeks to examine the legal and tax issues that are arising or could arise when wind farms are organized internationally.
In order to do this I will examine a case study involving a German community wind fund setting up wind turbines in Australia and the UK.
I. Legal structure of the German community wind fund
In Germany the majority of the wind funds are structured as a special form of a limited partnership, the GmbH & Co. KG. In this structure, a limited liability corporation (“GmbH”) assumes the position of the general partner in a limited partnership (“KG”).
The procurement of the private equity will be accomplished by the admission of investors into the GmbH & Co. KG. These investors will assume the position of the limited partners of the GmbH & Co. KG.
This way, the overall exposure of the GmbH & Co. KG is limited to the raised equity of the limited partners of the KG plus the equity of the GmbH.
II. Domestic German Taxation of a GmbH & Co. KG operating a wind power plant in Germany
It is important to first examine the German tax treatment of a GmbH & Co. KG operating a wind power plant installed in Germany.
In this regard, one has to differentiate between the level of the partnership and the level of the partners.
1. GmbH & Co. KG
The GmbH & Co. KG is considered to be tax transparent. Thus, the taxation of the income generally takes place at the individual level of the partners rather than the level of the partnership.
Nevertheless the GmbH & Co. KG will be subject to the German municipal trade tax (“Gewerbesteuer”), the German Value Added Tax (“Umsatzsteuer”) or the capital gains tax (“Kapitalertragsteuer”), if applicable.
2. Partners (Investors)
According to s 15 (1) No. 1 Income tax act (“Einkommensteuergesetz”; “EStG”) each partner is considered to be an entrepreneur receiving income from trade and business.
Under s 32a (1) EStG the maximum rate of income tax is 45.0% plus solidarity surcharge of 5.5% of the assessed income tax plus church tax, if applicable.
To avoid double taxation, the partners are entitled to a tax credit with respect to the municipal trade tax and the capital gains tax paid at the level of the partnership.
a. Acquisition costs
Because of the “5th building owner decree” released in 2003 all preliminary business expenses incurred at the level of the partnership are not promptly tax deductible anymore if the partnership will be characterized as a “buyer fund” (in contrast to a “producer fund”), which holds true for almost all of these partnerships.
b. Restrictions on the use of losses
According to s 10d EStG possible losses from the investment are allowed to be carried back up to one year to an amount of Euro 511,500. The use of remaining losses against profits in future profit years is restricted to profits up to Euro 1,000,000. Profits exceeding this threshold may only be offset up to 60%.
Pursuant to s 15a EStG the investor’s share in the loss incurred by the invest¬ment company may not be compensated with other positive income, as far as a negative capital account arises or increases due to loss allocations.
Moreover, according to s 15b EStG losses of these partnerships can only be offset against income generated in later tax years from the same source of income in order to limit tax avoidance through preconceived tax avoidance concepts.
If the partner disposes of his entire interest in the partnership, the taxation will be privileged according to s 16, 34 EStG.
III. International tax consequences
The regime of international taxation exists through bilateral tax treaties between the Contracting States, generally based upon model treaties developed by the OECD and the UN.
Treaties between developed countries (i.e. OECD members) are generally based on the OECD model whereas treaties between developing countries and developed countries are often, at least in part, based on the UN model.
The provisions of the OECD model treaty and the UN model treaty are mainly congruent. One important difference, however, is the broader definition of the permanent establishment in order to favour developing countries over their developed treaty partners.
1. Investment involving Germany and Australia
In this scenario a GmbH & Co. KG will be established in Germany operating a wind power plant situated in Australia.
a. Domestic taxation in Australia
In order to examine the international tax consequences, one first has to look at the Australian tax treatment of the investment.
(1). Income Tax
(a.) Operating income
The wind power plant will be considered to be a permanent establishment of the GmbH & Co. KG under Australian tax law. The GmbH & Co. KG will therefore be subject to Australian taxation on all Australian sourced income derived through that PE.
There is no branch profits tax in Australia. Thus, Australian branches of foreign companies are taxed on a net income basis at the corporate tax rate of 30% with the PE being required to lodge an annual
corporate income tax return.
The PE is also required to apply to the Australian Tax Office for an Australian business number and a tax file number.
(b.) Income from the disposal of the partnership interest
The GmbH & Co. KG is not considered to be a foreign hybrid limited partnership under Division 830 Income Tax Assessment Act 1997, because of the imposition of trade tax on the partnership under German tax law.
As a result the GmbH & Co. KG is not treated as a partnership but rather as a company for Australian tax purposes (Division 5A ITAA36).
Interest in the GmbH & Co. KG (i.e. in the wind power farm) is therefore treated as “taxable Australian property” for the purposes of the ITAA 1936 and ITAA 1997 and the disposal of the interest will be considered to be a Capital Gain Tax (“CGT”) event (A1) triggering CGT.
(2.) Goods and Services Tax (“GST”) (Australian Value Added Tax)
According to s 7-1 (1) A New Tax System (Goods and Services Tax) Act 1999 (“GST-Act”) an entity is liable to GST if it made a taxable supply under s 9-5 GST-Act.
Pursuant to s 9-5 GST Act an entity makes a taxable supply if it makes a supply for consideration, the supply is made in the course or furtherance of an enterprise that it carries on, the supply is connected with Australia and the entity is registered, or required to be registered for GST.
The sale of the electricity will be a taxable supply connected with Australia under 9-25 GST-Act.
Thus, the supply of the electricity will constitute a supply according to s 9-5 of the A new Tax System (Goods and Services Tax) Act 1999 (“GST-Act”) and the PE is therefore liable to GST under s 7-1 GST-Act.
In conclusion, the PE must charge GST of 10% separately in its invoice to the grid operator and can recover input tax levied on its operating expenses.
(3.) Depreciation
According to Division 40 of the Income Tax Assessment Act 1997 (“ITAA97”) the PE is entitled to write off plant, equipment and other depreciable items over their effective life. According to Taxation Ruling 2009/4 of the Australian Taxation Office the effective life of a wind turbine is 20 years.
aa. Allocation of taxing rights
Having established the Australian domestic tax treatment, it has to be examined whether the taxing rights remain with Australia.
Since the terms of the Australia/Germany Double Taxation Agreement (“Australia/Germany DTA”) prevail over the Australian domestic law according to s 4 in connection with Schedule 9 International Tax Agreements Act 1953 one has to look at the Australia/Germany DTA in order to allocate the taxing rights.
Both Germany and Australia are members of the OECD and the OECD commentary to the OECD Model Tax Convention on Income and on Capital (“Model tax convention”) is therefore decisive in interpreting the Australia/Germany DTA.
(1.) Operating income
According to Art. 7 (1) Australia/Germany DTA the profits of an enterprise of a Contracting State shall only be taxable in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment (“PE”) situated in that other state.
Since no example given in Art. 5 (2) Australia/Germany DTA covers the construction of a wind plant, Art. 5 (1) Australia/Germany DTA is decisive.
Thus, according to Art. 5 (1) Australia/Germany DTA, the wind plant must constitute a fixed place of business through which the business of an enterprise is wholly or partly carried on. This is the case.
The taxing rights therefore remain with Australia.
(2.) Income from the disposal of the partnership interest
The Australia/Germany DTA is not applicable to avoid double taxation in relation to the disposal of the partnership interest.
The Australia/Germany DTA was signed shortly after Australia joined the OECD but negotiated before Australia’s membership. The Australia/Germany DTA therefore omits the OECD Capital Gains article.
Moreover, according to the German tax authorities, the Australia/Germany DTA does not cover the Australian CGT.
The domestic tax laws of Germany and Australia are therefore decisive.
bb. Domestic taxation in Germany
a. Ordinary income
According to s 1 (1) EStG the taxation of income is governed by the world-wide principle in Germany.
Entities or persons with unrestricted tax obligations are therefore taxed on their world-wide income.
Thus, the GmbH & Co. KG will be subject to the German municipal trade tax and the partners will be liable to income tax.
(1.) Treaty benefits
However, according to s 2 General Tax Code (“Abgabenordnung”) the Australia/Germany DTA prevails over the German domestic law.
Germany qualifies partnerships as being fiscally transparent for treaty purposes and therefore not the partnership but each partner is entitled to the treaty benefits.
According to Art. 22 (2) (a) Australia/Germany DTA the profit share of the partner is excluded from German taxation under progression reservation with regard to the tax paid in Australia.
(2.) Progression reservation
According to Art. 22 (2) (a) Australia/Germany DTA the German tax authorities will take into account the items of income and capital excluded under Art. 22 (2) (a) Australia/Germany DTA in order to determine the rate of tax applicable.
The purpose of the progression reservation is to tax taxpayers according to their economic capability.
The German domestic counterpart of this treaty provision is s 32b EStG.
The provisions regarding the deductibility of losses (section 15a and 10d EStG) are also relevant for purposes of the progression reservation. Moreover, s 15b EStG prevails over the progression reservation.
b. Income from the disposal of the partnership interest
As mentioned above, the Australia/Germany DTA is not applicable. The domestic tax laws of Germany and Australia are therefore decisive.
If the partner disposes of his entire interest in the partnership, the taxation will be privileged according to s 16, 34 EStG.
According to the German tax authorities, Australia’s CGT is similar to the German income tax and it is therefore likely that the partners will be entitled to a tax credit with respect to the capital gains tax paid in Australia according to s 34c EStG.
1. Investment involving Germany and the United Kingdom
In this scenario a GmbH & Co. KG will be established in Germany operating a wind power plant situated in the UK.
a. Domestic taxation in the UK
(1). Income Tax
(a.) Operating income
There is no UK branch profits tax in the UK. If a non-UK resident company trades in the UK through a PE situated in the UK, it is chargeable to corporation tax on its “chargeable profits”.
The determination of the PE is in line with internationally recognized characteristics commonly used in the UK’s double tax agreements.
Section 19 of CTA 2009 defines “chargeable profits” as the trading income arising directly or indirectly through or from the PE and the other income and chargeable gains referred to in section 19(3) attributable to the PE in accordance with sections 20 to 32 of CTA 2009.
Thus, the GmbH & Co. KG is taxable on the profits arising directly or indirectly through the wind power plant in the UK.
(b.) Income from the disposal of the partnership interest
CGT is charged at 18% on the difference between what you paid for an asset and what you receive when you sell it, less your annual CGT exemption (£10100 in the tax year 2009/2010).
Thus, the profit made on the disposal of the interest in the partnership (i. e. in the wind power farm) will be subject to CGT at a rate of 18% in the UK.
(c.) VAT
According to s 4 (1) Value Added Tax Act 1994 (VAT Act 1994) VAT shall be charged on any supply of goods or services made in the UK, where it is a taxable supply made by a taxable person in the course or furtherance of any business carried on by him.
aa. Allocation of taxing rights
Having established the domestic tax treatment in the UK, it has to be examined whether the taxing rights remain with the UK.
On the 30 March 2010 a new DTA between Germany and the UK was signed in London (“Germany/UK DTA”).
According to Art. 7 (1) Germany/UK DTA the profits of an enterprise of a Contracting State shall only be taxable in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment (“PE”) situated in that other state.
Again Art. 5 (1) Germany/UK DTA is decisive and the wind power plant constitutes a fixed place of business through which the business of the enterprise is wholly or partly carried on.
The taxing rights therefore remain with the UK.
(2.) Income from the disposal of the partnership interest
The Double Taxation Agreement between Germany and the UK contains a Capital Gains Article based on the OECD model tax treaty (Art 13 Germany/UK DTA).
According to Art. 13 (5) Germany/UK DTA gains from the alienation of any property other than that referred to in the preceding paragraphs shall be taxable only in the Contracting State of which the Alienator is a resident.
Thus, if the investor disposes of his entire interest in the partnership, the gain will be taxable in Germany and will be privileged according to s 16, 34 EStG.